Friday, 12 April 2013

Buy Straddle : Option Straddle

BUY STRADDLE:

Buy Straddle is considered as a non-directional strategy and it is executed when option trader is anticipating a swing in stock price, but you’re not sure which direction it will go.

Typically, a straddle will be constructed with the call and put at the money (or at the nearest strike price if there’s not one exactly at-the-money). Buying both a call and a put increases the cost of your position, especially for a volatile stock. So you’ll need a fairly significant price swing just to break even
Profits can be made in either direction if the underlying shows volatility to cover the cost of the trade. Loss is limited to the premium paid in buying the options.

All that the investor is looking out for is the underlying to break out exponentially in either direction.

Nifty Options Long Straddle
Buy 1 ATM Index Call
Buy1 ATM Index Put



Investor View: Neutral direction but expecting significant volatility in underlying movement.

Risk: Limited to the premium paid.

Reward: Unlimited.

Higher Breakeven: Strike Price + net premium paid.

Lower Breakeven: Strike Price - net premium paid.


Illustration

Index
Nifty
Nifty Lot Size
50
Underlying Strike Price
5500
Call Premium
    81 (Call Premium Paid)
Put Premium
`    58 (Put Premium Paid)
Higher Breakeven Point
`  5639 (Strike Price + Call Put Premium Paid)
Lower Breakeven Point
`  5367 (Strike Price – Call Put Premium paid



Long Straddle



Reward Potential

Ø  Profit = Unlimited
Ø  Profit Achieved When Price of Nifty > Strike Price of Long Call i.e. 5500 + Net Premium Paid i.e. 139 OR Underlying Price of Nifty < Strike Price of Long Put i.e. 5500 - Net Premium Paid i.e. 139
Ø  Profit = Price of Nifty - Strike Price of Long Call i.e. 5500 - Net Premium Paid i.e. 139 OR Strike Price of Long Put i.e. 5500 - Price of Nifty  - Net Premium Paid i.e. 139

Risk Potential
Ø  Max Loss = Net Premium Paid i.e 139 + Commissions Paid
Ø  Max Loss Occurs When Price of Nifty  = Strike Price of Long Call/Put i.e. 5500

Nifty Closing Price @
Profit/Loss
5300
3050  (Profit)
5400
1600 (Loss)
5500
6950 (Loss)
5600
1600  (Loss)
5700
3050 (Loss)



Example:

Let us assume Nifty is trading at 5510 in Apr 2013. An options trader enters a long straddle by buying a Apr 5500 put for Rs 58/- and a Apr 5500 call for Rs 81. The net premium paid to enter the trade is Rs 6950 ((Call Option Premium + Put Option Premium) X 50 Lot size), which is also his maximum possible loss.

If Nifty is trading at 5700 on expiration in April, the Apr 5500 put will expire worthless but the April 5500 call expires in the money and will possess intrinsic value of Rs 200,Subtracting the premium paid of Rs 139, the long straddle trader's profit comes to Rs 61 X 50 Lot size i.e Rs 3050

On expiration in April, if Nifty is still trading at 5500, both the Apr 5500 put and the Apr 5500 call expire worthless and the long straddle trader suffers a maximum loss which is equal to the actual premium paid Rs 6950 ((Call Option Premium + Put Option Premium) X 50 Lot size)  taken to enter the trade.

For More Information about other strategies kindly click on below links
Guide To Options Basics
Long Call
Long Put
Short Call 
Short Put
Short Straddle
Synthetic Long Call